In the Courts

A jury convicted Goyal on a number of counts: one count of securities fraud, seven counts of making false filings with the SEC, and seven counts of making false statements to NAI's auditors. Addressing the first eight counts, the Ninth Circuit found that the government failed to carry its burden to show materiality. The court noted that the government had to demonstrate that “the accounting produced artificially higher revenue figures in certain periods that 'would have been viewed by a reasonable investor as having significantly altered the total mix of information made available.'” Id. (quoting Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988).)

To establish this at trial, the government relied on the stipulation of the parties that using sell-through (as opposed to sell-in) accounting in all of NAI's operations would have resulted in a materially lower revenue figure. The court found this stipulation too broad to be useful. The government only contended that sell-through accounting would have been required for the Ingram transactions. It did not, however, offer any evidence regarding the effect on revenues of changing the accounting for just the Ingram transactions. Thus, the Ninth Circuit found that the jury had “no basis to conclude that the misstatement of reported revenue resulting from the Ingram transactions was material.” Id. at 19750. The court dismissed the government's arguments that the jury could have inferred materiality based on the portion of total revenue (24%) that the Ingram sales represented because the jury never saw the proportions. Even if they had this figure, the jurors had no facts that would have allowed them to compare the difference between the use of sell-in accounting against the use of sell-through accounting for these transactions.

The remaining counts were based on Goyal's statements to auditors that: 1) the company's financial statements complied with GAAP; and 2) all sales terms had been disclosed. To meet its burden, the government had to establish that Goyal voluntarily made these statements and knew that they were false.

The court found that the government had failed to provide evidence to support all but one of its alleged GAAP violations and that, for that one violation, it had provided no evidence that Goyal's resulting false statement was willful and knowing. In order to use sell-in accounting, the relevant GAAP provisions required that the price to the buyer be “substantially fixed or determinable,” that the seller not have “significant obligations for future performance” to effect the resale of the product by the buyer, and that the quantity of “future returns” could be estimated.

The court found that the government offered no evidence that NAI had inadequate reserves to cover the terms of the deals with Ingram, which would have been necessary to establish a violation of the “substantially fixed or determinable” GAAP provision. The government also failed to offer evidence that NAI was unable to determine the likely rate of returns from Ingram, a necessary predicate to showing that NAI had violated the “returns” prong of GAAP.

However, the court did find that there was evidence on which the jury could have found that the buy-backs of software violated the GAAP prohibition on a “significant obligation[] for future performance.” The Ninth Circuit, however, found that the government had failed to offer any evidence from which the jury could have found that Goyal's misstatement was willful and knowing. The circuit court rejected the government's arguments that the jury could have inferred such intent. Specifically, the court noted that “Goyal's presumed knowledge of GAAP as a qualified CFO does not make him criminally responsible for his every conceivable mistake.” In addition, the court noted that his “general financial incentive” to see the company perform well “cannot be inherently probative of fraud.”

The Ninth Circuit also found that the government failed to provide any evidence that any non-disclosure of sales terms were willful and knowing. The sales terms of the end-of-quarter Ingram deals were disclosed in the after-the-fact debit memos that Ingram submitted and that were provided to auditors, although the initial buy-in letters had not been provided. The court found that a reasonable juror could have found that this was insufficient to constitute disclosure of “all sales terms.” It dismissed the government's arguments that Goyal's required intent element could have been inferred.

Notably, Chief Judge Alex Kozinski filed a concurring opinion identifying this as an example of “a string of recent cases in which courts have found that federal prosecutors overreached by trying to stretch criminal law beyond its proper bounds.” Id. at 19762.

Ninth Circuit Reverses Conviction of Former CFO of Network Associates Inc.

The U.S. Court of Appeals for the Ninth Circuit reversed the conviction of Prabhat Goyal, the former Chief Financial Officer of Network Associates Inc. (“NAI”), on the grounds that no jury could have found him guilty based on the evidence presented by the prosecution at trial. United States v. Goyal, No. 08-10436 (9th Cir. Dec. 10, 2010).

Goyal was the CFO of NAI from 1997 to 2001. In 1998, NAI added sales to distributors to its business model, which had historically focused on direct sales to end-users. The primary focus of the government's case was the manner in which NAI recognized the revenues generated from sales to distributor Ingram Micro. To help meet its quarterly projections, NAI made deals providing incentives to Ingram at the end of each quarter to boost sales. The government did not take issue with this practice; rather, the government contended that NAI improperly recognized the revenue from these transactions earlier than it should have. Id. at 19746-47. Specifically, the government claimed that NAI improperly used “sell-in” accounting, which recognizes revenue at the time a product is sold into the distribution chain (as opposed to when it is sold to the end user, known as “sell-through” accounting), to overstate revenues by recognizing these sales earlier than was appropriate. Id. at 19747.

A jury convicted Goyal on a number of counts: one count of securities fraud, seven counts of making false filings with the SEC, and seven counts of making false statements to NAI's auditors. Addressing the first eight counts, the Ninth Circuit found that the government failed to carry its burden to show materiality. The court noted that the government had to demonstrate that “the accounting produced artificially higher revenue figures in certain periods that 'would have been viewed by a reasonable investor as having significantly altered the total mix of information made available.'” Id . (quoting Basic Inc. v. Levinson , 485 U.S. 224, 231-32 (1988).)

To establish this at trial, the government relied on the stipulation of the parties that using sell-through (as opposed to sell-in) accounting in all of NAI's operations would have resulted in a materially lower revenue figure. The court found this stipulation too broad to be useful. The government only contended that sell-through accounting would have been required for the Ingram transactions. It did not, however, offer any evidence regarding the effect on revenues of changing the accounting for just the Ingram transactions. Thus, the Ninth Circuit found that the jury had “no basis to conclude that the misstatement of reported revenue resulting from the Ingram transactions was material.” Id. at 19750. The court dismissed the government's arguments that the jury could have inferred materiality based on the portion of total revenue (24%) that the Ingram sales represented because the jury never saw the proportions. Even if they had this figure, the jurors had no facts that would have allowed them to compare the difference between the use of sell-in accounting against the use of sell-through accounting for these transactions.

The remaining counts were based on Goyal's statements to auditors that: 1) the company's financial statements complied with GAAP; and 2) all sales terms had been disclosed. To meet its burden, the government had to establish that Goyal voluntarily made these statements and knew that they were false.

The court found that the government had failed to provide evidence to support all but one of its alleged GAAP violations and that, for that one violation, it had provided no evidence that Goyal's resulting false statement was willful and knowing. In order to use sell-in accounting, the relevant GAAP provisions required that the price to the buyer be “substantially fixed or determinable,” that the seller not have “significant obligations for future performance” to effect the resale of the product by the buyer, and that the quantity of “future returns” could be estimated.

The court found that the government offered no evidence that NAI had inadequate reserves to cover the terms of the deals with Ingram, which would have been necessary to establish a violation of the “substantially fixed or determinable” GAAP provision. The government also failed to offer evidence that NAI was unable to determine the likely rate of returns from Ingram, a necessary predicate to showing that NAI had violated the “returns” prong of GAAP.

However, the court did find that there was evidence on which the jury could have found that the buy-backs of software violated the GAAP prohibition on a “significant obligation[] for future performance.” The Ninth Circuit, however, found that the government had failed to offer any evidence from which the jury could have found that Goyal's misstatement was willful and knowing. The circuit court rejected the government's arguments that the jury could have inferred such intent. Specifically, the court noted that “Goyal's presumed knowledge of GAAP as a qualified CFO does not make him criminally responsible for his every conceivable mistake.” In addition, the court noted that his “general financial incentive” to see the company perform well “cannot be inherently probative of fraud.”

The Ninth Circuit also found that the government failed to provide any evidence that any non-disclosure of sales terms were willful and knowing. The sales terms of the end-of-quarter Ingram deals were disclosed in the after-the-fact debit memos that Ingram submitted and that were provided to auditors, although the initial buy-in letters had not been provided. The court found that a reasonable juror could have found that this was insufficient to constitute disclosure of “all sales terms.” It dismissed the government's arguments that Goyal's required intent element could have been inferred.

Notably, Chief Judge Alex Kozinski filed a concurring opinion identifying this as an example of “a string of recent cases in which courts have found that federal prosecutors overreached by trying to stretch criminal law beyond its proper bounds.” Id. at 19762.